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The Worst Is Yet To Come For Oil Prices

Dashing hopes for some oil producers who may have thought negative prices were a weird quirk, the June WTI contract fell sharply on Tuesday.

During intraday trading June contracts collapsed by more than 45 percent, falling close to $11 per barrel. The selloff demonstrated that the ruinous supply glut is not going away, and that the meltdown for the May contract was not just a bizarre anomaly, but representative of an acute state of oversupply in North America.

In fact, there could be a rerun of negative prices in a month’s time, according to several analysts. “We believe prices are likely to remain at basement levels in the short-term with further shut-ins forthcoming - expect late-May to bring similar price movements as the June contract rolls over,” Raymond James wrote in a note on Tuesday.

The malaise bled over into Brent prices, which collapsed below $20 per barrel by midday Tuesday, down more than 25 percent.

While forecasts have suggested that U.S. oil production could fall by 1 or 2 or 3 million barrels per day (mb/d) by the end of 2021, depending on who you ask, the lack of storage and collapsing prices means that shut ins could begin to mount very quickly. “[T]he physical reality of a still massively oversupplied oil market will likely exert downward pressure on the June WTI contract,” Goldman Sachs analysts wrote on Tuesday. “But with ultimately a finite amount of storage left to fill, production will soon need to fall sizeably to bring the market into balance, finally setting the stage for higher prices once demand gradually recovers.”

“This inflection will play out in a matter of weeks, not months, with the market likely forced to balance before June,” Goldman analysts warned. In other words, the U.S. oil industry could lose several million barrels per day in the next few weeks in what Goldman analysts called a “violent rebalancing.”

The crisis for the industry has entered a new phase, which will surely provoke more twists and turns. The Trump administration, flailing about, is trying to come up with ways to bailout the industry. On Monday, President Trump suggested that he would consider halting imports of oil from Saudi Arabia (“We’ll look at it”), while also reiterating his plan to fill up the strategic petroleum reserve with 75 million barrels of oil.

On Tuesday, he tweeted that he ordered the Secretaries of Energy and Treasury to come up with a rescue plan.

We will never let the great U.S. Oil & Gas Industry down. I have instructed the Secretary of Energy and Secretary of the Treasury to formulate a plan which will make funds available so that these very important companies and jobs will be secured long into the future!

Also on Tuesday, the Texas Railroad Commission punted on the idea of mandating production cuts. Two of the three commissioners were uneasy with the idea of voting on the proposal. Ryan Sitton, the one commissioner in favor of requiring a 20 percent cut in the state’s production, argued that not voting was itself a decision, allowing the market to mete out production cuts in a disorderly fashion. “I don’t believe that inaction on our part is acceptable,” Sitton said.

Meanwhile, there are other ideas for government intervention. The oil and gas industry is lobbying the Federal Reserve to loosen its $600 billion lending facility to allow drillers to use funds to repay debt, according to Reuters.

In addition, the “Treasury [Department] could guarantee loans to distressed firms in return for equity stakes or senior debt, and Washington could use its voting shares to compel shut-ins (i.e., as part of a bargain with OPEC+),” ClearView Energy Partners wrote in a note to clients.

While the oil market drowns in oversupply, there also seems to be a glut of unusual policy responses coming from Washington aimed at bailing out the industry.

But in the face of demand destruction on the order of 25 to 30 million barrels per day (mb/d), there is very little that the U.S. government can do to head off steep production losses and bankruptcies.

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The level of WTI price collapse yesterday was very unusual. However, the US shale oil producers face unusual problems, namely rising outstanding debts almost touching $1 trillion, inability to export their oil or having it consumed in the country because of the coronavirus outbreak and lack of storage of their own. Renting storage outside costs them far more than the contract price for their oil in the current situation. So they are trying to either virtually give it away or sell it at any price.

US shale oil producers have been for years taking advantage of OPEC+’s production cuts to enhance their market share at the expense of OPEC+ by producing excessively even at a loss and undermining OPEC+ efforts to support oil prices by trying to cap them. Shale oil producers haven’t even spared a thought for other oil-producing nations of the world whose livelihood they have trampled on for years with the full knowledge that US tax payers will bail them out. However, even US tax payers may eventually decide to let a bankrupt shale industry face its inevitable demise.

When the US shale oil producers had a chance to mend their ways by contributing to OPEC+-led global efforts to cut production in support of oil prices, they were very noticeable in their refusal. They have paid a heavy price for their obstinacy.

And with the coronavirus outbreak still raging across the world, both Brent and WTI crude prices will continue to face downward pressure with Brent oil possibly sliding to even $15 a barrel. There is nothing the world could do at present except to wait the end of the outbreak.

Meanwhile, it is far better for countries of the world to implement the strict measures that enabled China to control the outbreak and open the country to business again. This will certainly shorten the duration of the global lockdown and enable people to resume their normal activities including demand for crude oil rather than wasting their time making production cuts which are futile in the current circumstances.

Once the outbreak is contained, the global economy and China’s will behave like a patient who has been quarantined with no food. Once out of the quarantine, his appetite would be rapacious and this is exactly how the global economy and the global oil market will react with oil imports doubling if not tripling to recoup lost demand. Oil prices and demand will recoup all their previous losses.

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